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Pension tax tweak could leave thousands better off

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19/05/2021
The government has been urged to tweak the rules around accessing tax-free money from your pension, a move which it is argued could help many people enjoy a more comfortable retirement.

Pensions consultancy LCP noted that all too often savers are opting to withdraw their entire pot in one go, taking the 25% they can enjoy tax-free, and then sticking the rest in a traditional savings account which pays virtually no interest.

And it argued that adapting the rules so that the remainder of the pot can be left invested in the pension would ensure those pension savings last for longer, delivering a more comfortable standard of living in retirement.

I’ll take the whole lot

The firm noted that data from the Financial Conduct Authority, the main financial regulator, shows that it’s common for savers to take the whole of their pension pot out in cash. Figures from the regulator show that between October 2019 and March 2020, 55% of policies were cashed out in full, the equivalent of around 174,000 pots.

This is also much more likely to be the choice of those with smaller pension pots, worth less than £30,000.

However, LCP argued that lots of savers in this position do not take advice or guidance around their options, and so remove the money from a low-cost environment where it is managed to deliver some level of growth, and instead plonk the cash into a savings account paying little to no interest, and particularly not delivering any real term return due to the rate of inflation.

In fact, there are currently no savings accounts offering an inflation-beating rate

A better option

LCP has called for the rules to be tweaked so that savers can access that 25% tax-free cash, but leave the rest of the money invested in the pension so that it can continue to grow. This mirrors a previous suggestion from the FCA itself, but is reliant on government action.

The firm noted that while it is currently possible for savers to move the rest of their pension pot into a drawdown account, where it is invested, there are issues with this. For one, it’s not as simple as just taking out the whole pot, while LCP also argues that product charges are likely to be higher, with more onus on the individual saver to select a provider and investment mix.

Laura Myers, partner at LCP, said that there was a clear risk that the current rules for accessing tax-free cash would leave people worse off in retirement, as putting the money in a cash account means they miss out on investment growth on the remainder of their funds.

She added: “Even those who put the balance into drawdown risk moving into a higher cost environment with lower returns and poorer governance.  Changing the rules to allow people to access their tax free cash and leave the rest in their pension fund could be the best of both worlds.”

The calls come off the back of warnings that those approaching retirement risk running out of money, while there are concerns that younger people may not be saving enough for a comfortable retirement

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